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Is buying a house a good investment? Recently we spoke to the son of one of our Successful Investor Wealth Management clients who has to make a decision about housing, but needs to look at it from a financial point of view.
He and his wife bought a small starter home on a tiny lot in an old part of downtown Toronto. They both work in the north end of the city, so they had a long commute. But they liked the neighbourhood, and a number of friends lived nearby.
New considerations came up after their first child’s birth.
As it happens, a family member owns an investment house in the north end of the city, in an area that’s renowned for having some of Toronto’s top public schools. It’s twice the size of their current home, half as old, worth three times as much, and is in livable condition. It has a driveway that can park three or four cars, plus a garage. In winter, it has room for an enormous backyard skating rink. In summer, it can accommodate barbeque get-togethers with 50 or more guests. The location makes the house an easier commute for both of them.
The family member/owner is willing to accept a yearly rent equal to 1.2% of the value of the home, which is less than his interest cost. He’s even agreeable to making modest improvements at his own expense, since he can write off the cost against his rental income. The house plays a key role in his estate plan, since it’s part of a long-term land-assembly project. He is willing to let them live there for as long as they want, or until he dies, with little if any change in the rent. He just wants a trouble-free tenant.
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They asked our advice on buying a house before, and they asked again when this sell-or-hold question came along.
Back in 2015, we told them the same thing we’ve repeatedly told other clients and Inner Circle members. Since the 2008/2009 recession, central banks in Canada, the U.S. and other countries have set off on a unique economic experiment. They have artificially pushed interest rates down to historically low levels, for two reasons: to keep the economy out of recession, and to make it possible to pay the interest costs on extraordinarily high and rising government debt.
Now, with this sell-or-hold decision to make, the situation has changed. House prices and interest rates have both gone up substantially. This means far more potential Toronto-area house buyers have been priced out of the market. In addition, the artificial interest-rate paradise is coming to an end. Interest rates have gone up and our view is that they will keep rising.
Our advice for this particular young family was to accept the sweet deal on the rental house, and sell the starter. They can save the money they’d otherwise pay on property taxes toward a down payment on their dream home. Their incomes are likely to rise, since they are in the prime of their careers, so they’ll have that much more to add to the dream-home fund. When they are ready to buy, here are some tips:
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Tax pluses. Homeowners get a tax-free, rent-free benefit of having a place to live. Profits on sales of principal residences are also tax-free.
For maximum investment safety, buy the most common house in your area: a two-story four-bedroom, say, or a three-bedroom bungalow. It’s ordinarily easiest to sell.
Growth in nearby job and leisure opportunities raises land demand. That pushes up land values. But land supply can increase too, from rezoning of industrial or agricultural land to residential use, or from cuts in minimum lot sizes.
For maximum capital gains, buy a small house on a big lot in an improving area. It may sell for little more than land value. Years later, you may be able to demolish the house and divide the land into several building lots.
Another thing to consider is the quality of nearby schools, even if you don’t have children. Properties near good schools tend to have higher values, and attract a wider range of buyers when it’s time to sell.
For maximum enjoyment, buy a home that’s a little bigger and nicer than your family will need in the next, say, 10 years. Chances are you won’t regret it.
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If you do invest in real estate beyond owning your own home, it’s crucial to learn as much as you can about property management, taxes and other legal issues, and the local market. Make sure you are prepared to hold for years if not decades, and to invest additional funds if necessary.
Real estate investment has provided a foundation for many fortunes. But you rarely hear about the successful investors who bought and/or sold rental properties at the wrong time, and have a loss or meagre profit to show for their efforts.
Legalities and tax changes are some of the biggest factors impacting real estate investing. How have these factors changed your interest in real estate investments?
In today’s economic climate, what would you say are the benefits of buying a house as an investment?
Pat McKeough has been one of Canada’s most respected investment advisors for over three decades. He is the founder and senior editor of TSI Network and the founder of Successful Investor Wealth Management. He is also the author of several acclaimed investment books. This article was first published on June 26, 2018, and has been republished on the Hub with permission.
